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Before I get into the subject matter of this article, let me congratulate investors in Vringo (NASDAQ:VRNG) on a settlement against Microsoft (NASDAQ:MSFT) regarding the '420 and '664 patents, the same patents at-hand in the popular Google (NASDAQ:GOOG) litigation. I have been very vocal that I did not think a settlement would occur due to pending USPTO re-examination on invalidity (non-patentability) on the '664 patent, a final (but non-final in essence, due to appeals) rejection by the USPTO on the '420 patent, and the time it would take to go to trial (main thesis outlined in my earlier articles). This article deals with the Microsoft settlement and what it really means, and the stunning amount of new legislation aimed at stopping patent assertion entities (or patent trolls, non-practicing entities, patent pirates, patent privateers, whatever term you please) like Vringo that threaten their long-term business sustainability.

Settlement (Capital)

With the above being said, I personally think the settlement is disappointing. According to the SEC filing, Vringo will receive $1MM (before attorney fees), 5% of whatever remedy Google eventually pays for usage of the aforementioned patents, and 6 patents revolving around telecommunications, data management, and other similar technology. The 5% is capped, however, but this limitation will not come into play unless Vringo receives more capital that "substantially exceeds the judgment previously awarded at trial."

This is essentially an option; Vringo was awarded approximately $15MM from Google from an Eastern District Court of Virginia (EDVA) jury back in November, but is currently attempting to garner approximately $600MM in future royalties from Google (could be more/less dependent upon GOOG growth rate, royalty rate, royalty base, etc.). Google's argument is substantially less than this, as they argue a lump sum payment of a couple million should be awarded. If Vringo wins their argument of 3.5%-7% of 20.9% of Google's U.S. Revenue (50% of overall), then the Microsoft cap comes into play.

This settlement is obviously disappointing on the capital side. Estimates from hundreds of millions of dollars have been diligently conducted and John Tinker of Maxim estimated $71MM; here is my calculation. Bing owns 16.5% of the U.S. search engine market share compared to Google's 67% (comScore). When the Google lawsuit was filed, Vringo was seeking $696MM in damages. Using this apportionment, it could have been estimated that Vringo was attempting to garner $175MM. In addition, Vringo was attempting to go for willful infringement (winning so would have constituted a 3x multiplier), making the total value around $525MM, absent legal fees. However, I have not yet seen a brief on alleged damage numbers, so it is hard to definitively know what damages Vringo was attempting to seek.

Settlement (Patents)

As is true with other patents that Vringo has received externally (an acquisition of a patent portfolio from a questionable unknown company quantumStream (website) was tucked away in a 3Q2012 ER), Vringo has not released any material information surrounding the six Microsoft patents assigned. Also true with the quantumStream patents, the six new MSFT patents are not listed on Vringo's IP website. Microsoft owns 40000+ patents, and they are just starting to add value to their patent portfolio after not knowing what to do with it for years.

->> Note: As of this writing, there are unconfirmed rumors flying around on stock forums that the patents assigned to Vringo are:

· 6327073

· 6556983

· 7356563

· 7987233

· 7477247

· 7716359

Settlement (Aggregate)

Vringo does not need any more patents, instead, they need to generate substantial revenue from the patents as that is their business model. Companies like Microsoft, Google, ZTE, etc. have underlying businesses that are supported by their patents. Vringo currently makes mobile applications that do not generate a substantial amount of revenue whatsoever. To date (from a monetization of intellectual property standpoint), they have generated approximately $31MM in revenue (conglomerate jury damages + MSFT settlement amount), while spending $22MM to purchase hundreds of patents from Nokia (NYSE:NOK), of which few are being used in the ZTE litigation. This leaves a delta of $9MM, while diluting shareholders twice last year in addition to unusually high employee compensation (just look at new CFO Anastasia Nyrkovskaya's $300K salary with a $25K signing bonus in addition to 300K stock options.)

Vringo vs. Google is still in post-trial motions and multiple outstanding lawsuits with Chinese telecom giant ZTE subsidiaries are the only suits on the plate from an IP viewpoint. While the Google ruling from Judge Raymond Jackson could come at any time now, the ZTE lawsuits will not have the chance to generate revenue, sans settlement, until late 2013 at the earliest (middle 2014 from ZTE Germany due to their legal system, as described in my above linked article). Generating revenue from patents will not happen overnight.

Another interesting thing about the Microsoft settlement is the lack of a press release. Vringo has sent out press releases about corporate presentations and patent assignments, but failed to send one out about this settlement.

The share price agrees with this letdown as well, as it has just about come back to where it was before the settlement was announced.

Legislation concerning NPE's

As I have said before, Vringo is a non-practicing entity, which means they don't have an underlying business model that supports the patents they are trying to gain revenue from. There has been much legislation, both approved and pending, that is focused at NPE's, or could negatively affect their long-term business model sustainability:

· S. 866 (aka Patent Quality Improvement Act) -> Senator Charles Schumer of New York recently introduced S. 866. This provision will amend Section 18 of the America Invents Act (AIA), which involves the transitional program for Covered Business Method Patents (CVMP). Section 18(d)(1) currently reads:

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S. 866 would change "a financial product or" and replace it with "an enterprise, product, or". It would also eliminate the sunset (temporary) provision (Section 18(a)(3) of AIA). This obviously broadens the scope of industries that would be covered under AIA; it would require that the USPTO review and "sign off" on covered patent infringement suits before they go to Court, providing an alternative to Court. More information can be found on Schumer's website.

  • Saving-High-Tech Innovators from Egregious Legal Disputes (SHIELD) Act (described under "Reasons to be Bearish on Vringo" subset D)
  • H.R. 2024 (End Anonymous Patents Act) -> Introduced by Congressman Ted Deutch of Florida in May. It would add more transparency around actual owners of patents, claims, and sales/transfers of patents to be disclosed to the PTO. For example, if approved, this bill would mandate that Vringo disclose their intellectual property to the public and make it easily searchable (more on Deutch's website).
  • Patent Abuse Reduction Act -> Introduced by Senator John Cornyn of New York specifically targeting the procedure of technological patent litigation. This article by the Hill suggests this bill is focused at companies who "have no plans to create any products but buy-up cheap patents, find companies using similar technologies, and then threaten to bring them to court for infringement." That essentially describes Vringo's business model. This bill would give defendants more power in material discovery to mitigate Court fees.
  • Vermont State Legislature (bill H. 299) -> Although this does not affect Vringo in any way, states taking strides like Vermont could eventually affect Vringo. Recently, the Vermont Attorney General filed a Consumer Protection Complaint against MPHJ Technology Investments, LLC for "bad faith assertions of patent infringement" pursuant to H.299 (signed by Governor Peter Shumlin 5/22).

Keep in mind most of the federal bills are introduced, not definitive legislature. Dependent on which branch of government the elected official resides (Senate [designated with S], House [designated with HR]), the sponsored bill has to be approved by the other collective branches before enactment. However, each Bill, either pending or approved, is consistent with the President's viewpoint on patent trolling, in addition to the Justice Department's, International Trade Commission's, and the FTC's. I expect swift, unified movement to pass the aforementioned legislation through the checks and balances in order to provide much needed relief to the out-matched PTO.

Another interesting development is the ruling in CLS Bank v Alice Corp from Judge Rader of the Fed. Circ. In essence, he rules that most software patents are ineligible, as the following statements were included in the appellate disposition:

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(click to enlarge)

(click to enlarge)

From ruling (linked) and here.

The ruling itself is extremely confusing, but more information can be found at the hyperlink a couple lines up. This case is expected to eventually reach the Supreme Court; either way, the decision would mark a huge judgment regarding patent infringement lawsuits.

Conclusion

My view has always been that Vringo would get paid its huge payout from Google, but the recent drama regarding the PTO re-examination(s) on invalidity (non-patentability) on '664 and '420 and inevitable NPE legislation makes me doubt this position. Vringo desperately needs an underlying business model. Without one, they will get pummelled by a appellant with deep pockets (Google), a time-consuming litigation process with practicing entities across multiple international jurisdictions (ZTE), and an uncertain macro-NPE legal environment. I originally believed I/P Engine teamed up with Vringo in order to validate Andrew K. Lang (owner of '420 and '664) and give him proper recognition for his IP. Now, they are pursuing a patent assertion business model that is widely frowned upon, and at the moment, not living up to expectations.

I do not short stocks, but it is hard to argue not to given the consistent fade after any catalyst (see Microsoft settlement, court document saying Vringo was in settlement discussions with Microsoft, multiple ups-and-downs in Google litigation, etc.). After all of these events, the share price has dropped back down after investors/traders disseminated this information and the hysteria died down. Vringo needs to either start monetizing its patents, or develop an underlying business model that is supported by its IP. Without this, the long-term sustainability, and investors'/traders' patience, is jeopardized.

Source: Vringo: Where's The Money?